Pandora Drops 10% On Apple News: Time To Buy?

News June 3 that Apple (Nasdaq:AAPL) is set to release iRadio, its own internet radio station, as early as next week sent Pandora's (NYSE:P) stock tumbling more than 10%. Although Pandora's stock is up 85% year-to-date through May 31; the latest revelation isn't good news. Is it enough for supporters to bail on the stock? Or is this the perfect time to buy? I'll have a look.

IPO
Since its IPO in June 2011, it's traded as high as $26 (opening day) and as low as $7.08 in November 2012. Going public at $16 per share, it's only been able to close out a month's trading above its IPO price on just on two occasions. Two weeks shy of its two-year anniversary as a public company, the news that Apple's going to go head-to-head with it is just another bump in its volatile road. Pandora went public in 2011, a year in which the average IPO experienced a negative return of 10%, only the second time in 11 years (the other was 2008) that new issues have lost ground in their inaugural year as a public company. Call it a curse, but this class did not get off to a good start. Whether Pandora can bounce back depends entirely on its ability to make money; something it has yet to master.

Business Model
Pandora announced first quarter earnings May 23. It lost $28.5 million from its operations, 41% more than in Q1 2012. Meanwhile its non-GAAP revenue increased 58% year-over-year to $128.5 million. On the surface the revenue numbers are fantastic. However, when you consider that its content acquisition costs increased by 48.6% in the quarter, one must come to the conclusion that its costs are rising faster than its revenue. That's a game you can't play for too long without your business viability being called into question.

Supporters of Pandora will point to the mobile market as its saving grace. Its total non-GAAP mobile revenue in Q1 (advertising and subscriptions) grew 101% to $86.7 million accounting for 67% of its overall revenue. Furthermore, its total mobile revenue per thousand (RPM) impressions was $26.15 compared to $19.16 in last year's first quarter. That's a 76% increase in the monetization of its mobile listeners. Those who believe in Pandora's business model assure skeptics like myself that it's moving in the right direction. While there's no doubt the figures don't lie, it's not the same as delivering a business model that will make money. CEO Joe Kennedy suggests its 40-hour monthly listening limit on mobile users will keep its content acquisition costs from escalating beyond its control. In the first quarter its content costs were 66.1% of revenue compared to 69% in Q1 2012. So it's clear something positive is happening. However, the increased margin still led to an additional $8 million in operating losses over last year.

Throw Apple Into The Mix
In the first quarter Pandora increased marketing and sales expenses by $16.6 million thanks in large part to a 67% increase in its headcount. That's a good thing if its sales staff have the field all by themselves. However, if Apple enters the fray the money spent for additional manpower might be all for nought. While Pandora is paying a compulsory royalty rate of 12 cents per stream, Apple has negotiated directly with both Universal Music and Warner Music at a rate of 16 cents per stream.

Why would Apple do this? Because it makes it more difficult for competitors like Pandora to convince the government that its compulsory rate is unfair when compared with broadcast, satellite and cable. Essentially, Apple will outspend Pandora and other internet radio services until they all scream "Uncle" and cede the marketplace.

Bottom Line
Between Apple, Google (Nasdaq:GOOG) and Sirius XM Radio (Nasdaq:SIRI), you have three much bigger companies prepared to do battle in the world of streaming music. All of them except Pandora make money. I don't understand why individual investors feel the need to put money into companies like Pandora when there are plenty of profitable options available that carry far less risk.

Should you buy Pandora's stock at $15 and change?

I wouldn't but that doesn't mean you shouldn't. Just remember that any time you buy stock in a business that's consistently proven to be a money loser, you're participating in speculation, not investment. Pandora's chances of being a home run get harder by the day. Apple's imminent entry into the music streaming business is just one of many shots across Pandora's bow. It could be the next Netflix (Nasdaq:NFLX) or the next Groupon (Nasdaq:GRPN). Either way it's got a tough road ahead.

As they say in the Shark Tank: "For that reason I'm out."

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.